[In part one of a Gamasutra opinion piece, former NCSoft Europe CTO Adam Martin takes a close look at what made the PlayStation 1 and PlayStation 2 such enormous successes, and what's right and wrong with the PlayStation 3 business today.
The PlayStation 1 redefined gaming, opening up entirely new markets of game-players and breaking all records for console sales. Its successor, the PlayStation 2, is still the biggest-selling game console of all time -- and continues to sell, despite being technically inferior to its competitors for almost four years.
Altogether, the PlayStation family has earned Sony billions of dollars in profit. The latest incarnation -- the PlayStation 3 -- has now been on sale for a couple of years.
But Sony Corporation recently announced its first annual net loss in 14 years -- just over $1 billion -- and predicted that 2009 would net an even larger loss
, close to $1.5 billion.
What happened? And what's next for the former king of the console market?
This article is entirely my personal opinion, based off public fact and / or rumor. Any “facts” mentioned are taken from public sources (press releases, Wikipedia, etc) -- lots of people have access to more accurate figures, but they're under NDA, so I can't use them.
Finally, note that this is an opinion piece, not a commercial report: take it with a pinch of salt, come to your own conclusions, and don't blame me if it's woefully wrong.
Facts, Expectations, and History
PS1 created some new markets for games players -- perhaps most notably the cash-rich 20-35 year-old young professionals -- and destroyed all records for console install bases, redefining the core sales targets for all future consoles. Today, its is over 100 million. Before PS1, Sony had zero presence in the games industry; afterwards, it was the market leader by a huge margin.
PS2 built upon the PS1's new markets, and outsold it even in the face of direct competition from a giant company (Microsoft) in the form of the good, innovative, Xbox. Total installed base today is over 140 million. It's also still selling quite well at retail; even a year after PS3 launched, in some territories PS2 was often the best-selling console month to month (beating ALL other consoles).
Fundamentals of the Console Business: Costs
Next-generation consoles (for each successive new generation) typically sell at a 10 percent-50 percent loss. Within 12-24 months, they typically sell for a 10 percent-50 percent profit, and by year 5 they typically sell for a 5 percent-30 percent profit even with price drops that bring the price down to typically 25 percent of what it was at launch.
The gradual increase in profit - despite a drop in retail price - is mostly accounted for by gradual improvements in manufacturing. Some of these are automatic - the microelectronics industry each year makes the same components more cheaply, smaller, and less electricity-hungry.
Some of them are down to product revision - less hungry components require less powerful other components, enabling some of the more expensive components to be "downgraded" to cheaper siblings, or improving the circuit layouts, or programmatic design of the system. Finally, some improvements come simply from factory/assembly-line improvements - upgrading the fabrication machines, inventing better assembly processes, etc.
It would be possible to wait until the above improvements made your console profitable before launching - but most console companies can "afford" to make a net loss for the first six to 12 months, and that gives them a six to 12 month lead on their competitors, so they deliberately launch loss-making hardware.
Fundamentals of the Console Business: Launch
It's long been believed that new consoles succeed or fail on the strength of the game portfolio available at launch: without games, a games console is a worthless hunk of plastic and metal. Microsoft's and Sony's attempts to make people think of a console as "something other than a games machine" have not (yet) changed this.
At and shortly after launch, the PS1 had what was - at the time - a huge portfolio of games: Sony had taken the above to heart and made sure there were lots of people developing for their new console. They had a lot to prove, they were new to the market, and (as noted) this was considered essential at the time.
At launch, the PS2 was backwards compatible with the PS1: a PS2 buyer was guaranteed thousands of games they could purchase immediately. This was supplemented again by a large number of launch / post-launch titles that Sony made sure were present.
Generally speaking, even with exceptionally strong IP (for instance, Nintendo's world-best brands of Mario, Zelda
, etc), it's been necessary to have either a large portfolio, or huge hardware sales, to survive in the console market.
Fundamentals of the Console Business: Two-Horse Racing
Generally speaking, a games console is so expensive that the vast majority of consumers will only purchase one or two of them at a time. Where they purchase more than one, it is typically because there is a large differentiator between the portfolios of games available.
As a gross simplification, one net effect of this is that it's generally not possible to make a substantial profit in the console industry unless your console is one of the top-two best-selling consoles.
Summary of the PS3: FAIL
- Just looking at traditional consoles, PS3 is languishing in third place ... out of three ... with a mere 15 percent or so of market-share
- If you include the handheld consoles that can play PS1 and PS2 quality games or better, PS3 has around 7 percent overall market-share
- The PS3 still sells at a 10 percent loss per unit, according to Sony (March 2009 - 2.5 years after launch)
- The PS3 is not backwards compatible and has only a medium portfolio of games
- The PS3's main non-cosmetic new feature - PSN - has a very small portfolio of games
Business Analysis: What's Right and Wrong With the PS3 Today, and What Matters to Sony?
Simplifying massively … for Sony as a corporation, the core issues with PS3 that really matter are something like:
The relevance and meaning of "Profit" is obvious. Equally, "Scale" is fairly obvious when you look at how dependent Sony corporation is on the revenues from the PlayStation family: it is simply not good enough for PS3 to be "merely" profitable (i.e. the profit margin is greater than 0 percent), it also has to achieve generous absolute profits (i.e. the total cash that PS3 brings in needs to be greater than some number of hundreds of millions of dollars - otherwise it's not worth the effort; it'll barely be “a rounding error” on the quarterly accounts).
And, even if both those can be achieved, Sony needs them to be maintained long-term. They've gone on record to state that the PS3 is expected to be a profit center for a decade or more. Even at the highest levels of realistically-achievable profitability, they've spent so much money on PS3 to date that they're going to have to keep raking in the cash from it for a long time to pay it all back.
And, above all, they have Microsoft -- one of the world's largest, richest, software companies -- constantly snapping at them: at any moment, MS could turn around and change the stakes or rules of the competition fundamentally (they have the resources to do so, in theory).
At the other end of the scale, the giant they dethroned (Nintendo) is now extremely cash-rich, and cash-rich companies can afford to take many risks and make many strange and fantastical gambles. Sony needs uniqueness and product strength to provide a buffer-zone against the unpredictable moves their competitors might make.
Revenue as Profit-Driver
Sony's PS3 revenue (probably - I don't work for Sony, but the following are all standard for consoles and/or are widely believed to be sources of revenue for Sony) comes from:
- Selling the hardware to retailers (PS3 units, plus Sony-branded peripherals such as additional controllers)
- Selling their own in-house developed software to retailers
- Selling third-party developed software (where Sony owns the IP) to retailers
- Licensing third-party software (where they don't own the IP), and pushing it to retailers
- A small fixed-price tax on every unit of third-party software that is sold to retailers by other companies
- A small percentage tax on every unit of third-party software that is sold direct to consumer via PSN
Therefore, Sony can increase revenue by increasing any of the following, in decreasing order of difficulty:
- Unit sales of new PS3s via retail each month
- Unit sales of new Sony-owned software
- Unit sales of new, non-Sony-owned software
- Unit sales of non-Sony-owned PSN software
Traditionally, as a consumer electronics company, Sony has been exceptionally well-adapted for "selling hardware to retail". It's safe to assume that they're probably doing about as well at shifting hardware units each month as any company could do in their position (although we'll revisit that a bit later).
Selling more of your own software - having to do all the marketing, etc. - is easier to improve on for a non-software company simply because there are a lot of other companies who could show you how to do it better.
But ... selling more of other-people's software - software that is already being marketed by someone else, and is costing you nothing - has many more opportunities for being increased.
But it's not just easier. Like-for-like, it may be more profitable too: third-party sales tend to account for the majority of all software sales on PlayStation platforms. The per-unit revenue to Sony is much smaller from third-party titles, but since there's so many more of them, a 1 percent increase in third-party sales could even have a greater effect on the company's bottom-line than a 1 percent increase in first-party sales.
Revenue: Third-Party sales
There are two aspects to the third-party sales. First of all, there's sheer straightforward overall volume of 3rdParty sales (V(3p)):
V(3p) = NumStudios(3rdparty) x AvgTitlesPerStudio(3rdparty) x AvgUnitsPerTitle(3rdparty)
Independently increasing *any* of those factors increases the overall volume - and directly increases Sony's revenue.
Of course, it's not possible to "independently" alter those factors. For instance, allowing anyone and everyone to become a PS3 dev studio would almost certainly decrease the AvgUnitsPerTitle(). Or, conversely, persuading one single awesome studio to switch from - say - 360-exclusive to 360 + PS3 would increase both NumStudios() and also AvgUnitsPerTitle().
Secondly, there's specific projects - the megahit titles, the blockbusters.
sold 13 million copies in its first year, approximately one third of them on PS3. Assuming an AvgUnitsPerTitle of 0.5 million, and assuming that GTA IV
took about twice as long to develop as a typical PS3 title, a single title from Rockstar was "worth" the output of perhaps as many as 4 other studios.
Finally, there's PSN. PSN sales are dismally low, given the (apparently/allegedly) very high penetration of PS3 owners who've actually hooked their PS3's up to their broadband internet. These should be the easiest of all to increase.
Also... note that this is a different sales-channel to all the other sources of revenue - it does NOT use retail, instead it is a wholly-Sony-owned channel. This means that, for instance, Sony can charge not just for "new" sales but for, well, "any" sales in that channel.
Rather than re-use the formula for revenues from retail third-party sales, I'm going to suggest a slightly different formula for the revenues from PSN, which I think will help with later analysis:
R(PSN) = NumTitles(PSN) x AvgSalesPerTitle(PSN) x ( AvgPricePerTitle(PSN) + ( AvgMicroPaymentsPurchased(PSN) x AvgMicroPaymentPrice(PSN) ) )
That provides some perspective on the revenue situation right now, which matters for the "Scale" point above - but says very little about the "Profit" point, since it ignores costs. Here's a quick look at ways that Sony could increase PS3 Profit:
- Increase revenue-per-unit-PS3 sold via retail
- Reduce hardware production costs (increases profit per unit PS3 sold)
- Increase the revenue-per-title sold via retail
- Increase the tax-per-unit-sold via retail
- Increase the number of studios making PS3 titles
- Increase the volume of PS3 titles made by each studio
- Increase PS3 installed base 
- Increase the number of PS3-exclusive games 
- Decrease the number of "[competitor]-exclusive" games (ditto)
- Increase the volume of PSN titles
- Increase the revenue-per-title of PSN titles
 - (potentially REDUCES profit if PS3 units are selling at a loss, but ... it probably INCREASES the AvgUnitsPerTitle (since there's more consumers), which increases the revenue from the software tax. In a double-whammy, it also increases the desirability for studios and publishers to ship on PS3, in turn increasing the number of titles they choose to ship on PS3.)
 - (potentially prevents consumers who own multiple consoles from choosing to purchase a game for "the other console"; potentially also forces some consumers to purchase a PS3 in order to play the game)
...but I don't believe all of those are necessarily wise routes to take - and some of them are more subtle than they may first appear.
In the second and final part of this editorial, to be published later in the week, we'll look at solutions -- what Sony can potentially do to change its position in the market, given where it is today.
[Adam Martin is an MMO Consultant, specializing in business, operations, and technology. As the European CTO for NCsoft he oversaw internal development in Europe, helped set up the EU dev studio, and sat on the steering group for Social Networking in games and marketing. He is currently setting up a new kind of iPhone publisher, with a simple mantra: don't screw the developers.]